Bankruptcy Rules Get Tougher

What does the new law mean for consumers? We'll tell you.

LOOK OUT DEBTORS: The bankruptcy reform bill signed into law by President Bush today has been branded a consumer foe by bankruptcy attorneys and consumer advocates alike. The new legislation, which goes into effect six months from now, is the biggest rewrite of the bankruptcy code in 25 years and was pushed for eight years by banks and credit card companies.

Here are the most important changes, along with details on how they will affect those filing for bankruptcy protection.

1. More people forced into Chapter 13
Currently, more than twice as many people file for Chapter 7 bankruptcy than for Chapter 13. Under Chapter 7, most of the filer's unsecured debts are written off, whereas Chapter 13 requires the consumer to repay all or part of their debts within three or five years.

Once the law is in place, however, most people will be forced into Chapter 13 even if they can't afford it, says Stephen Elias, a bankruptcy attorney and co-author of Nolo Press's "How to File for Chapter 7 Bankruptcy." That's because the new Means test will disqualify from Chapter 7 filing anyone whose income is higher than the median for the state (as determined by the IRS and Bureau of Labor Statistics, or BLS) and who can afford to pay at least $6,000 or 25% of their unsecured debt (whichever is greater) over five years. This will affect many middle-income individuals or families who earn above their state's median, but are forced into bankruptcy after accruing large debts, often because of divorce or medical emergencies, Elias says.

2. Chapter 13 repayment schedules become unaffordable for many
Under the existing law, when a consumer files Chapter 13 bankruptcy, the court determines his or her repayment schedule based on their monthly income and basic living expenses. If, for example, you earn $3,000 a month and your basic living expenses (including rent, utilities, food, clothing and transportation) are $2,000, the remaining $1,000 will be distributed to your creditors.

Under the new law -- and by applying the Means test -- the courts will determine the amount to be repaid to creditors based on the basic living expenses in your state or county as determined by the IRS and BLS. The catch here is that your actual expenses are often higher than what the IRS says they should be in its Collection Financial Standards (national, state and county schedules are available here), says Jay Fleischman, a bankruptcy attorney with Fleischman Law in New York.

3. The cost of filing bankruptcy increases
The new law will also make the disclosure of the debtor's assets a lot more detailed, says Fleischman. Think of it as a court audit of every bankruptcy filing: If any mistakes or omissions are found, the case will be dismissed and the attorney will be held legally responsible for all costs, fees and sanctions. That doesn't come out of the debtor's pocket directly, Fleischman explains, but the overall costs of filing would still go up as a necessity. That's because rather than risk being sanctioned and fined by the court, attorneys will start requiring their clients to obtain full professional appraisals of all of their household's goods and furnishings. By initial estimates, that may cost as much as an additional $500 to $1,500.

The lawyers themselves may also increase their fees because of the additional workload, Elias says. For example, he would have to go to court a lot more, instead of filing the paperwork directly from his office, he explains. "I charge $500 now," he says. "There's no way I would be able to charge so little after the bill goes into effect." He says attorney's fees would double. Currently, they range between $500 and $1,000.

In addition, the law will require consumers to go through mandatory credit counseling for six months before filing and a financial management course during the time they are repaying their debts. That will impose even more expenses on people who can least afford them, says Elias. But given the new alternatives, it might simply be their best shot at digging themselves out of debt.